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HCR Law Events

16 November 2022

Who’s in control? The balance of power between the investor member and the management board

Day-to-day management of an limited liability partnership (LLP) business  will not rest with an investor member, but in the absence of statutory rights to protect its interests, what provisions should be included in the LLP agreement to secure a level of participation?

Members of an LLP are well advised to scrutinise their agreements, and deficiencies can be amplified for investors who tend not to be involved in the day-to-day management of the business.

How do LLPs operate?

It is established law that all members are bound by an LLP deed, the terms of which are so deeply embedded that departure from those terms (or indeed acceptance of a breach of those terms) cannot give rise to a claim repudiatory breach of contract, the appropriate remedy instead being damages. As such, LLP agreements are constitutional documents and quasi-contracts, akin to articles of association of a company, that continue to bind all members according to their terms from admission to exit and beyond.The leading authorities on this point, Reinhard v Ondra LLP [2015] EWHC 26 (Ch) and Flanagan v Liontrust Investment Partners LLP [2015] EWHC 2171 (Ch) are unequivocal and highlight the dangers of entering into an LLP agreement as an investor either on the terms of an existing LLP agreement, or as a start-up where the focus is on getting the business up and running. By the nature of these businesses and relationship between the participants, LLPs most frequently operate according to agreements between a number of individuals, with profit and capital sharing arrangements, voting rights, exit arrangements, duties, and participation in the management being highly unsuitable for an incoming corporate member.

Rights and protection – investors v shareholders

Whilst clearly documenting the financial and exit arrangements between the investor and other members of the LLP is critical, so too are the management powers and oversight rights. These provide a level of protection for investors who, unlike shareholders in a company, do not have entrenched statutory rights: investors and their advisors ignore this aspect of investing in an LLP at their peril.

Particular issues arise for non-FCA authorised investors in an FCA authorised entity; for example, fund management businesses often favour LLP models. The FCA regulatory regime requires delegation of management responsibilities for regulated functions to a management body of individuals to whom senior management functions are allocated. The individuals involved may, or may not be, members of the LLP, but either way, this precludes the investor member from day-to-day management of the business in which it is financially interested.

Due to the unique character of LLP members as a combination of “shareholder” and “director” (to draw on company equivalents), all members are bound by their fiduciary duties to the LLP, including the duty to act in the best interests of the LLP, which may conflict with the investor’s wish to protect its investment. Investors need to navigate the course carefully and are well-advised to reflect their consideration of the LLP’s best interests in board meetings where member decisions are made.

How can an investor secure its position beyond the financial terms?

  • Through a series of well-considered member reserved decisions, combined with corporate member veto rights or weighted votes;
  • Through the rights to appoint and remove individuals to and from the management board, without requiring a compulsory retirement (individual member) or causing unlawful dismissal (employee), and setting terms of reference for the management board; and
  • By ensuring visibility of day-to-day management, right to liaise with the management board and rights to supply information for their consideration.

In each case, investors must walk the tightrope between regulatory obligations, fiduciary duties, and protecting their investment.

LLPs are excellent vehicles for investment and conducting business, with structural and financial flexibility that simply cannot be achieved through a company. Nevertheless, the unique nature of membership and importance of the LLP agreement should not be, but so frequently is, underestimated.

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About the Author
Rachel Khiara, Partner

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